Welfare effect analysis of pay-as-you-go pension system: Deconstruction from the perspective of relative utility and social equality

Abstract

This paper studies the redistributive effects of two major pay-as-you-go pension systems by constructing an intergenerational iterative model which does not only considers standard utility but also relative utility. The study find that the two main pay-as-you-go pension systems are both sustainable. If we consider different preferences, then the choice of pension system should depend on the question of whether individuals are more interested in the absolute level of consumption or in the consumption related to a reference group. If the latter is more important, the Beveridgean system is superior, it provides greater protection for vulnerable groups than the Bismarck pension system, and the pension income after retirement is relatively more balanced, but the price is a lower level of consumption in the long run compared to an economy with Bismarckian system. If individuals prefer instead the absolute level of consumption, the Bismarckian system is better, because it guarantees a comparable higher level of consumption, but the disadvantaged groups face a higher risk of poverty and the degree of social inequality will be relatively higher. However, it is important to note that in the long run, only the level of consumption differs, not the speed of growth or number of children.